Thanks to Microsoft, Apple, Nokia lawsuit/licensing triple team, OEMs might be tempted to take the deal

The Vergeis citing "sources familiar with Microsoft's plan" as saying that Windows Executive Vice President (EVP) Terry Myerson is considering offering Windows RT and Windows Phone for free. The move could be a game changer for Microsoft, which is struggling in key mobile markets including budget laptops, tablets, and smartphones.

I. Free at Last?

Some viewed Microsoft's decision to offer free upgrades to Windows 8.1 for Windows 8 users as a shift in direction; others argued that the release was analogous to a service pack, which Microsoft has traditionally released for free.

Needless to say, offering an operating system to OEMs for free would be a far greater seismic shift for Microsoft. The "official" MSRP is $120 USD for Windows RT, but the rates that Microsoft sells it to OEMs at are individually negotiated. According to a report by VR-Zone in mid-2012 Microsoft was asking $80-95 USD per license (with the median asking price around $85 USD) for Windows RT tablets. Following poor pickup of Windows RT, Microsoft reportedly cut licensing fees to $30-45 USD by June 2013, according to reports by ComputerWorld and The Wall Street Journal.

Microsoft current charges anywhere from $5 to $30 USD per Windows Phone license.

In Jan. 2012, Chinese phonemaker ZTE Corp. (SHE:000063) revealed in an interview with TrustedReviews (UK) that Microsoft was charging between $20 and 30 USD per Windows Phone 8 license. Larger OEMs have been rumored to get more favorable deals; Reutersreported in June 2011 that Samsung Electronics Comp., Ltd. (KSC:005930) (the world's biggest smartphone maker) was paying only $10 USD per Windows Phone license.

Aside from ZTE's apparent tip, the closest to confirmed licensing rate info we have on Windows Phone comes from financial filings from Finnish phonemaker (and Windows Phone maker) Nokia Oyj. (HEX:NOK1V). While there was a two-way flow of money between Microsoft and Nokia (Microsoft paid Nokia around $1B USD to use Windows Phone over Android), the net direction of the flow was to Microsoft.

A 20-F filing by Nokia for fiscal 2012 revealed that Nokia was expected to pay Microsoft €500M ($688M USD) more than it received through the end of 2016. Given that Nokia shipped 7m Windows Phones in Q1 2013, 7.4m in Q2, and 8.8m in Q3, that works out to something in the neighborhood of 32-35m expected sales for 2013. Assuming no growth (an unrealistic assumption, as Nokia doubled its Windows Phone sales from 2012 to 2013), sales should work out to 125 - 150 million units through 2016. That's about $5 a license -- at most -- likely even less (of course, Nokia's devices unit later would be sold to Microsoft scrapping that deal).

But in October the rumor mill was buzzing following a Bloombergreport that Microsoft offered HTC Corp. (TPE:2498) free Windows phone licenses, if it commits to a large volume of handsets (perhaps exclusivity).

II. Why "Free" is Good for Microsoft's Bottom Line

In Q3 market analysis form Interactive Data Corp. (IDC) indicated sales of 8.9m Windows Phone units (indicating Nokia accounted for basically all of the platform's sales). Windows RT -- the version of PC Windows that runs on CPUs bearing ARM Holdings plc's (LON:ARM) titular licensed architecture -- moved 200,000 units in Q2 2013 (about half a percent of the 51m+ tablets that were sold in Q2). It's safe to assume that Q3 sales were bad or worse, given that some OEMsbailed on Windows RT with the launch of Intel Corp.'s (INTC) Bay Trail platform.

So Microsoft’s net loss in revenue had it offered Windows Phone and Windows RT for free to OEMs would have been around $50M USD -- a drop in the bucket for a company that made $5.24B USD last quarter in net income.

As the fall of RIM/BlackBerry demonstrated, it's absolutely vital to stay relevant in the mobile consumer market, in order to stay relevant in the enterprise market. So it's a smart move for Microsoft to sacrifice roughly 1 percent of its net earnings if that expenditure will gain it ground in the mobile market.

That brings us to a final point -- will it work?

III. Will OEMs Quit Android to Save Money?

Currently there's only one major alternative to the Windows OS family in terms of a third party platform -- Google Inc.'s (GOOG) Android OS. Likewise on budget laptops the only widely adopted alternative is Chrome OS. Chrome OS and Android are "free" to OEMs in the sense that Google doesn't collect license fees and offers to share advertising revenue with the OEMs. However, these operating systems aren't truly free in the long run.

The question is whether a free Windows OS would be cheaper. You know with certainty that Microsoft won’t sue you, so that reduces your potential licensing fees to payments/lawsuits costs with Apple and Nokia. Further, you're safe from most software patents, as Apple and Nokia have committed to licensing agreements with Microsoft.

Thus the only expense you have is potential payments on hardware infringements or infringements on design patents. As the Nokia v. HTC conflict shows, this can still be an issue -- particularly if you buy your chips in jurisdictions where licensing deals from chipmakers don't transfer to their customers (e.g. Taiwan). However, even if Windows Phone/Windows RT OEMs are forced into small licensing fees regarding hardware patents or small redesigns to escape design infringement claims, this still will likely be half what a top Android OEM today is paying.

The Nokia, Microsoft, and Apple patent licensing/lawsuit triple team may make the "free" Windows Phone the only financially feasible option for some OEMs, like HTC. [Image Source: NeoWin]

Simply put together Microsoft, Apple, and Nokia are triple teaming phonemakers. This approach may eventually make getting the licenses necessary to sell a smartphone or tablet so expensive that Android becomes financially infeasible for top OEMs. And now Microsoft deftly maneuvering to position itself as a seeming knight in shining armor, and offering "free" licensing -- if you use its OS.

Smaller Android OEMs who might be under less legal pressure invariably will have to weigh these financial benefits against the cost of redesigning for a new operating system and the cost to users of having a more limited app selection.

But overall free licensing could be a game changer to Microsoft's mobile campaign, and help Microsoft sustain profits in the long term in the enterprise sector, which current drives most of its revenue.